Sector-Specific Shocks and the Expenditure Elasticity Channel During the COVID-19 Crisis

Abstract

The COVID-19 economic crisis differs from past recessions in terms of the sectors and occupations that are being hit first. In this paper we propose a model with sectoral and occupational heterogeneity and non-homothetic preferences over sectors. That is, households' consumption bundles depend on income and they cut consumption on high income-elastic sectors when labor income falls. We first document that contact intensive occupations are concentrated in just a few, high-income-elasticity sectors. By contrast, production/manufacturing occupations are distributed widely across sectors. We then compare a COVID-19 type shock affecting service sectors first to a more ``standard" recession affecting manufacturing in our model calibrated to match the U.S. economy. Our main result is that the increase in labor income inequality in the COVID-19 recession is one and a half times the increase in a normal recession due to the fact that contact intensive service workers are low income and work mainly in high income-elasticity sectors.